Bond Traders Query Bear Market as Yields Ebb Back From Brink

(Bloomberg) -- Bond traders want to know: Is this really what a bear market looks like?

Ten-year U.S. yields flirted with the highest levels since 2014 Wednesday as longtime pillars of support for the world’s biggest bond market showed signs of eroding, raising the specter of even deeper losses. After all, global central banks are gradually pulling back stimulus and senior government officials in China are said to have recommended that America’s biggest foreign creditor slow or halt purchases of Treasuries.

It didn’t last long: 10-year Treasuries erased earlier losses to trade nearly unchanged by day’s end, thanks to a $20 billion auction of the notes that drew the strongest demand since 2016. It provided traders with a firm signal that buyers will still turn out at the right price in the world’s biggest bond market. 

Positioning data to be released Thursday may give a hint as to whether traders were confident enough to wager on a further rally from current levels. In Asian trading Thursday, yields fell after China’s State Administration of Foreign Exchange said in a statement that the report on the nation’s Treasury investing "might have cited wrong sources or may be fake news," an apparent reference to the Bloomberg News story published on Wednesday. It said such investments are decided by market conditions.

Even Bill Gross, the Janus Henderson Group fund manager who called the start of a bear market this week, is skeptical of how much damage can be done in the $14.5 trillion Treasuries market. He said Wednesday that he doesn’t foresee dramatic losses. In fact, he expects the 10-year yield may only rise 15 to 25 basis points more by year-end.

“The bear market that I’m talking about is a mild one,” Gross said in a Bloomberg Radio interview. “I don’t think we’re headed for investment Armageddon.”

The 10-year yield was at 2.53 percent at 2 p.m. in Tokyo on Thursday, down from as high as 2.595 percent the previous day. Traders watching whether it would break above its 2017 high of 2.63 percent, spurring a steeper selloff.

Therein lies the rub about calling for doomsday in this market: History has proven time and again that yields rise and fall in fits and starts. It takes a dramatic change in the fundamental outlook for U.S. fiscal and monetary policy (think Donald Trump’s election victory most recently) or turmoil in riskier assets to really jolt bonds one way or the other.

And while 2018 has brought some telegraphed risks into sharper focus, nothing has rocked the foundation of the Treasuries market, said Aaron Kohli, an interest-rate strategist at BMO Capital Markets in New York.

To Kohli and John Briggs at NatWest Markets, the latest runup in yields was magnified because the market was caught offside, going all-in on the flattening yield-curve trade that dominated the end of 2017. With the smallest spread between short- and long-term debt in a decade, it was “vulnerable to a correction,” Briggs said.

Late Entries

Positioning data suggest that speculators who were late getting into the flattening wager got burned. Hedge funds and other large speculators had built up their largest net-long position in Treasury bond futures in 13 years as of mid-December, and mostly held their ground in the ensuing weeks.

“A lot of the speculative accounts started to pile into the flattening trade -- there was this bandwagon effect,” Kohli said. On the other hand, “if you were sitting in the flattener for a year, you’ve done really well. Why not take a little profit?”

With the angst about the latest selloff seemingly quelled for now, investors may look to Thursday’s $12 billion 30-year bond auction for any signs that buying interest is returning. BMO’s Kohli said he’s “a bit more worried” about how that sale will go, compared to the 10-year offering.

Yet as Wednesday’s session showed, buyers are waiting in the wings.

BMO suggests buying 10-year Treasuries if yields climb to 2.6 percent. Citigroup Inc. on Wednesday said it closed out its recommendation to bet against 30-year Treasuries. And Dan Ivascyn, group chief investment officer at Pimco, said the firm would consider adding Treasuries on further bond-market weakness, according to a tweet from Reuters.

--With assistance from John Gittelsohn

To contact the reporter on this story: Brian Chappatta in New York at bchappatta1@bloomberg.net.

To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, Mark Tannenbaum, Jenny Paris

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